A wrapped token is a cryptocurrency token that represents another cryptocurrency on a different blockchain, or even a real-world asset on a particular blockchain. Think of it like this: if you have a physical bar of gold, you can “wrap” it by putting it in a secure vault and getting a certificate that represents ownership of that bar of gold. You can then trade or use that certificate without physically moving the gold.
In the crypto world, the “gold bar” is your original cryptocurrency (such as Bitcoin), and the “certificate” is the wrapped token (such as Wrapped Bitcoin, or WBTC). The original asset is locked in a digital vault (often controlled by a custodian or smart contract), and an equivalent amount of wrapped token is created(minted) on the target blockchain. This wrapped token is pegged 1:1 to the value of the original asset, meaning that 1 WBTC should always be worth 1 BTC.
How does a wrapped token work?
The process typically involves:
- Blocking: You send your original cryptocurrency (example: BTC) to a secure address or smart contract.
- Creating (Minting): Once the original asset is locked, an equivalent amount of wrapped token (e.g. WBTC) is created or “minted” on the target blockchain (e.g. Ethereum).
- Usage: You can now use this wrapped token on the target blockchain for various purposes such as:
- DeFi app participation (lending, lending, yield farming).
- Trading on decentralized exchanges (DEXs ) operating on that specific blockchain.
- Transferring assets more efficiently or with lower fees to another network.
- Burning: When you want your original cryptocurrency back, you send the wrapped token back to the mechanism (custodian or smart contract), which “burns” (destroys) the wrapped token and releases your original asset from the vault.
Why is a wrapped token important?
A wrapped token is important for:
- Interoperability: they act as bridges between otherwise isolated blockchain networks, allowing assets to move and be used in different ecosystems. This helps create a more connected and fluid crypto landscape.
- Improved liquidity: By allowing assets to be used from one blockchain to another, wrapped tokens increase overall liquidity in the decentralized finance (DeFi) space. For example, Bitcoin liquidity can be leveraged within Ethereum’s vast DeFi ecosystem through WBTC.
- Increased utility: They allow cryptocurrencies that are not natively compatible with certain smart contract platforms (such as Bitcoin) to participate in the rich array of dApps and protocols on those platforms.
- Potentially lower fees and faster transactions: Sometimes, using a wrapped token on another blockchain could offer lower transaction fees or faster confirmation times compared to using the original asset on its own chain.
Wrapped token advantages and disadvantages
Advantages wrapped token
- Cross-chain functionality: Use assets from one blockchain on another.
- Access to DeFi: Participates in lending, borrowing and other decentralized financial activities with a wider range of assets.
- Increased Liquidity: Unlocks value from otherwise isolated assets.
- Potential for lower fees/faster transactions depending on target blockchain.
Wrapped token disadvantages
- Custodial risk (for some): many wrapped tokens, such as WBTC, rely on a centralized custodian to hold the original assets. This introduces a point of centralization and trust, which can be a risk if the custodian is compromised or mismanaged.
- Smart contract risk: Smart contracts used for packing and unpacking may have vulnerabilities that attackers could exploit.
- Complexity: The packing and unpacking process can be complex for new users.
- Fees: There may be fees associated with packaging and unpacking tokens.
A wrapped token is an ingenious solution to the blockchain interoperability challenge, enabling a more integrated and versatile cryptocurrency ecosystem. Want to invest in cryptocurrencies? Whether you want to buy or sell, our website has everything you need! Check the daily updated rates on the Cryptocurrency Price List page and use our dedicated profit calculator to effortlessly calculate your profit or loss based on the buy and sell prices and the amount invested.